March 14, 2017

Australian Markets Weekly: 13 March 2017

What can the history of Australian monetary policy tell us about the current monetary policy debate?

Australian monetary policy history lesson

  • The market is now pricing two interest rate hikes in Australia by the end of 2018.
  • The experiences of 1994 and 2002 seem relevant to consider – in 1994 the RBA waited for nearly eight months before following the Fed. In 2002, an overheating housing market saw the RBA remove some monetary policy accommodation.
  • Despite these similarities, there are important differences at this time, not least that inflation is below the target. NAB’s forecasts continue to see a weaker 2018 economic outlook than the RBA and a slow return of inflation to the target.

What can the history of Australian monetary policy tell us about the current monetary policy debate?

In a week when the US Federal Reserve is expected to increase the Fed Funds rate, the market is now pricing that the Australian cash rate will be 2% by the end of 2018 (i.e two 25bps rate hikes). There have also been a number of commentators arguing that the RBA will be forced to raise interest rates to attempt to slow very strong house price growth. These developments occur as the RBA Governor has recently stated that he would prefer unemployment to come down more quickly and inflation to return to target more quickly, but is more concerned about the financial stability considerations of too rapid an increase in household debt, to consider reducing rates further.

We thought a consideration of recent Australian monetary policy history might help shed some light on some of the different factors likely to be debated by markets. Of course, policy will ultimately be determined by how the Australian economy, labour market and in particular inflation turn out over the next few years.

Two periods seem relevant for special consideration, given the current confluence of events: (i) the experience of 1994, a period when the Fed began tightening after a long period of easing, as the US economy strengthened; and (ii) the experience of 2002, a period which saw an improvement in Australian (and global) growth along with very strong Australian house price and credit growth (though then the house price rises were more uniform nationally than is presently the case).

The first overall point worth making is that anyway you measure it, this has been a particularly long easing cycle around the world and in Australia. The Fed cut and then held US interest rates near zero for over eight years, before the first increase in December 2015. Only one further rise occurred at the end of 2016, though as the Fed Chair has warned, a faster pace of rate rises is seen as appropriate this year as the Fed is nearing its dual inflation and unemployment mandates.

In Australia, it’s also been a long easing cycle, with cash rates beginning to decline in November 2011 and the latest interest rate cut in August 2016, rates having been unchanged since. Australia’s easing cycle may have been longer still, had the RBA not been in the fortunate position of being able to unwind some of the emergency easing put in place during the Global Financial Crisis, as China and commodity prices rebounded.


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